Online Appendix: Bank Competition, Risk Taking and Their Consequences

Online Appendix: Bank Competition, Risk Taking and Their Consequences Xiaochen (Alan) Feng Princeton University - Not for Pulication- This version: Novemer 2014 (Link to the most updated version) OA1. Controlling for County Fixed Effects Empirical analysis in the paper shows that, in counties where the lending market was competitive, the response of average loan-to-income ratio to housing risk was strong after controlling for many county characteristics such as wage growth, suprime and securitization percentage and etc. However, one might still e concerned that highand low-competition counties are different in an unoservale way. Ideally, one would need to include county fixed effects to exclude all possile confounding factors aout the specific county. In this section, I control for county fixed effects y comparing anks lending in the same county and show that competition affected lending decisions at the ank level. I look into more details how two anks in the same county ehaved differently. Consider two similar multipleranch anks A and B lending mortgage loans in a county C. Suppose that ank A mainly operates in competitive mortgage markets and ank B has usiness in concentrated markets. According to the risk shifting hypothesis derived aove, from 2000 to 2005, ank A would raise the loan-to-income ratio more than ank B in county C. Moreover, if county C has inelastic housing supply (i.e., high house price volatility), the difference etween the lending ehaviors of anks A and B would e the largest. To test this effect, I perform the following analysis. (OA1) LT I 00 05,c = α c + β 1 whhi + β 2 whhi Elas c + β 3 X + ɛ,c where LT I 00 05,c is the 2000-2005 percentage change in average loan-to-income ratio of loans issued y ank in county c, α c is county fixed effect, whhi is the weighted average of Herfindahl indexes for ank as of 2000, Correpsondance: Economics Department Princeton University, Fisher 001, Princeton, NJ 08544, USA. Email: xf@princeton.edu. 1

Elas c is the housing supply elasticity of county c, and X is a list of ank controls including the size, type, and loan amounts of the ank 1. If the risk shifting mechanism is present, one would expect that a higher degree of market competition for the ank (i.e., lower whhi ) is associated with greater LT I 00 05,c, meaning that β 1 < 0. Moreover, the difference should e the largest in counties where house price is most volatile (i.e., lower elasticity), suggesting that β 2 > 0. Tale OA1 shows the empirical estimates. In column (1), I regress the change in LTI for the ank on its weighted average of HHI alone. We can see a slightly negative correlation ut it is statistically insignificant. In columns (2) and (3), I interact the weighted average HHI with the housing supply elasticity of the county. In column (2), we have β 1 < 0 and β 2 > 0 and oth estimates are statistically significant. The interpretation of this result is that, for counties with very inelastic housing supply, a higher competition level (i.e., lower HHI) for the ank implies a larger increase in LTI from 2000 to 2005; for elastic-supply counties, this difference was much weaker. Columns (3) reports similar results for the same exercise y adding ank controls (e.g., ank size, ank type, headquarter state fixed effects) in the regressions. In columns (4)-(6), I repeat the same exercise ut measure ank competition in a county y concentration ratio instead of the Herfindahl index. One can see that very similar estimates are otained. In sum, in this section, I include county fixed effects y comparing anks facing different levels of competition and lending in the same county. I show that anks that face higher competition lent more aggressively than other anks from 2000 and 2005, and this difference was the most significant for areas where house price grew the fastest. OA2. Bank-Level Portfolio Changes Raising the loan-to-income ratio is one dimension that anks could increase their load on housing risk. Another dimension is that multi-ranch anks might adjust their loan issuance through their ranches. Increasing loan issuance aggressively in inelastic areas increases the correlation of the return of their mortgage portfolio with the aggregate housing shock. Banks mainly operating in competitive mortgage markets would e more willing to issue loans to inelastic areas through ranches as to increase the correlation of loan performance to the house price shock. For each ank, I compute the following measures. First, I compute the weighted average of the Herfindahl index (or concentration ratio) of counties for this ank as of 2000, denoted as whhi. For 2001 and 2005 separately, I also compute the weighted average of elasticities of counties in which the ank had mortgage lending activities in, where the weights are the county s share in the ank s mortgage portfolio. I define this 2001-2005 difference as Elas 01 05 for each ank. The change in average elasticity consists of two parts: some mechanical change caused y natural loan growth in some areas and the intentional part that anks adjusted. The mechanical change takes into account the situation that some counties in the ank s portfolio experienced growth in population and total loan issuance which results in the change in the ank s average elasticity. To correct for this difference, I compute 1 I restrict my sample to ank-county pairs where the county represents at least 3% and at most 50% of the ank s total mortgage portfolio as these anks would have similar lending strategies with respect to this county. 2

the measure AverageChange 01 05 defined as what the change in average elasticity would have een if the ank maintained the same market shares in all counties as its market shares in 2001. Sutracting it from the change in elasticity, i.e., Elas 01 05 choice across counties. AverageChange 01 05, would then measure the intentional change in ank s portfolio Specifically, the empirical model to test this prediction is shown elow. (OA2) Elas 01 05 AverageChange 01 05 = β 0 + β 1 whhi + β 2 X + ɛ where Elas 01 05 is the change in the weighted average elasticity of mortgage issuance across counties for ank, AverageChange is the average change in elasticity fixing the ank s market shares in all counties as of 2001, whhi is the weighted average Herfindahl indexes of counties in which ank lent mortgages in 2000, and X is a list of ank controls including ank size, total mortgage issuance, and type of the ank. As the housing supply elasticity measure is not availale for all counties, I only focus on anks for which the measure covers at least 70% of their loan portfolio as of 2001 2. Tale OA2 reports the regression results. Column (1) reports the regression result of the change in elasticity in relation to average Herfindahl for the ank. The coefficient is positive and significant, suggesting that anks faced with low concentration HHI (i.e., high competition) intentionally increased loan issuance in inelastic counties. In column (2), I only retain anks that had elasticity measure covering over 99% of their portfolio and find similar a similar estimate. Column (3) repeat the exercise y including ank controls, e.g., ank size, securitized share, and ank type 3. In columns (4)-(5), I also include fixed effects for the headquarter state of the ank. The coefficient on the weighted average HHI of the ank remains positive and statistically significant, especially when I only look at states that have a large numer (> 150) of anks so the headquarter state fixed effects would not take out too much information. In columns (6)-(7), I use weighted average concentration ratio instead of Herfindahl index for each ank as of 2000. One can see that higher ank-level competition predicted greater shifts towards inelastic areas. In sum, in this section, I show that anks competing more strongly in the mortgage market increased the weight of inelastic-county loans in their portfolio. The return of their portfolio was made more correlated with the house price shock. This is consistent with Prediction 2 that higher competition encourages anks to take on the housing risk through the extensive margin y issuing more loans in higher-risk areas. 2 I also require that each ank at least issued 100 mortgage loans as of 2005 and winsorize the change in elasticity ( Elas AverageChange ) y 2.5% at each tail of its distriution. These steps essentially allow me to reduce the noise caused y very small anks in my sample. 3 Bank type is defined as the type of regulatory agency that oversees the ank. The regulatory agency can e Office of the Comptroller of the Currency (OCC), Federal Reserve System (FRS), Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS), National Credit Union Administration (NCUA), Department of Housing and Uran Development (HUD), and Consumer Financial Protection Bureau (CFPB). This information is otained from the HMDA data. 3

OA3. Other Roustness Checks In this section, I perform roustness checks on the the main regression (1). Specifically, I consider the following three categories of concerns. First, to address the concern that securitized loans did not remain on anks alance sheet, I exclude all securitized loans from the sample and check if the non-securitized su-sample yields similar estimates. I also include the quadratic form of house price volatility as controls. Second, I alternatively drop all refinancing loans. This is to address the question that characteristics of refinancing loans may contain different information than those for home purchase loans. Third, I also distinguish different types of financial institutions according to their regulatory agency. Performing this exercise is to address the concern that the capital structure and/or other items on the alance sheet may also affect anks lending decisions. The HMDA dataase identifies the regulatory agency of the financial institution for each mortgage loan. I specifically drop all thrift institutions and keep commercial anks only. Regression results are reported in Tale OA3. In Columns (1)-(3), I drop all loans in the sample that were securitized either y government-sponsored enterprises (GSEs) or private institutions. In column (1), we see that the coefficient on the interaction term etween house price volatility and ank concentration is strongly significant. The coefficient remains significant after controlling for the quadratic term of house price volatility, as shown in Column (2), or controlling for other county-level variales, as shown in Column (3). For Columns (4)-(5) and Columns (6)-(7) I keep only home-purchase loans and owner-occupied loans, respectively. One can see that the coefficients on the interaction term remains statistically significant with and without various controls. In Columns (6)-(7), I only keep mortgage loans issued y commercial anks in the sample. Moreover, I also distinguish lending decisions made y national anks (i.e., operating in more than 15 states as of 2000) from those made y regional anks (i.e., operating in fewer than 15 states as of 2000). One can see that the coefficient on the interaction term etween house price volatility and ank concentration is negative and statistically significant. Moreover, eing issued y national anks offsets this relationship significantly. This result is consistent with the main specification in this paper and shows that the findings here were not driven y capital structure or changes to other (unoserved) items on the alance sheet. In sum, in this section, I present roustness checks y dropping securitized loans, refinancing loans and loans issued y thrift institutions. Empirical results are roust to these alternative settings. 4

Tale OA1 Banks Competing in the Same County This tale presents regressions of ank-level average loan-to-income change from 2001 to 2005 in a given county on the average Herfindahl index for the ank. Bank-level Herfindahl index (whhi), representing ank concentration, is the weighted average HHI of counties in which the ank had mortgage lending activities in 2001. To ensure that anks in each county are comparale, I require that each ank must have at least 3% and at most 50% of its total mortgage loans in the county and that each county must have at least 15 anks for the inclusion of county fixed effects. Standard errors are clustered at the county level. (1) (2) (3) (4) (5) (6) Percentage change in loan-to-income, 2001-2005 Bank Average Concentration 0.31 (1.01) 3.19 (1.30) 3.44 (2.36) 0.17 (0.21) 0.75 (1.30) 1.07 (0.33) Bank Average Concentration Elasticity 1.50 (0.56) 1.68 (0.57) 0.35 (0.13) 0.42 (0.13) Share of Loans Securitized 0.03 0.05 (0.03) Concentration Measure HHI HHI HHI C.R. C.R. C.R. Bank Size and Type Controls N N Y N N Y Bank Headquarter State F.E. N N Y N N Y N 2159 2159 2159 2159 2159 2159 R 2 0.06 0.07 0.08 0.06 0.07 0.10 ***, **, * denote statistical significance at the 1%, 5% and 10% levels. 5

Tale OA2 Bank Portfolio Shift and Bank Competition This tale reports regressions of the 2001-2005 change in the intentional changes in weighted average elasticity of counties in which the ank had mortgage lending activities. This intentional change is measured y the actual change in weighted average elasticity for the ank minus what the average elasticity would have een if the ank maintained constant market shares in each county from 2001 to 2005. Bank-level Herfindahl index (whhi), representing ank concentration, is the weighted average HHI of counties in which the ank had mortgage lending activities in 2001. Since the elasticity measure of some counties is missing, I require that at least the elasticity measure should cover at least 70% of the mortgage portfolio of the ank. To ensure that my results are not driven y extreme cases, I require that each ank issued at least 100 mortgage loans as of 2001 and winsorize the change in average elasticity at 2.5% at each tail of its distriution. Standard errors are roust. (1) (2) (3) (4) (5) (6) (7) Change in average elasticity Weighted Average HHI 2.71 (0.77) 3.24 (1.47) 2.78 (0.79) 0.96 (0.64) 1.65 (0.71) Weighted Average 0.78 0.39 Concentration Ratio # of Mortgage Loans 0.97 (0.25) 0.62 (0.23) 0.62 (0.24) # of States 0.001 (0.001) 0.002 (0.001) 0.002 (0.001) # of Counties 0.08 Share of Loans Securitized 0.03 (0.03) 0.00 Elasticity Measure Coverage Rate > 70% > 99% > 70% > 70% > 70% > 70% > 70% # of Banks in the State All All All All > 150 All All Bank Type F.E. N N Y N Y N Y Bank Headquarter State F.E. N N N Y Y N Y N 2203 613 2203 2203 1782 2203 2203 R 2 0.01 0.013 0.03 0.42 0.42 0.03 0.43 ***, **, * denote statistical significance at the 1%, 5% and 10% levels. 6

Tale OA3 Roustness: Non-Securitized, Home-Purchase, and Commercial-Bank-Issued Loans This tale presents regressions of the change in loan-to-income ratio in the county on local house price volatility, instrumented y housing supply inelasticity (Saiz (2010)). The change in loan-to-income ratio is the percentage growth of the average loan-to-income ratio in a county from 2000 to 2005. Bank concentration is measured y the Concentration Ratio (i.e., total market share of top-10 lenders) in that county as of 2000. National anks are defined as lending mortgages in at least fifteen states as of 2000; local anks are defined as lending mortgages in less than fifteen states as of 2000. All regressions are weighted y the numer of population in the county as of 2000. Standard errors are clustered at the CBSA level. 7 House Price Vol. HP Vol. Bank Concentration HP Vol. Concentration {National Bank} Bank Concentration (C.R.), 1995 HP Vol. {National Bank} Concentration {National Bank} {National Bank} (1) (2) (3) (4) (5) (6) (7) (8) (9) 3.60 (0.84) 5.25 (1.52) 0.15 + Percentage change in LTI, 00-05 Non-Securitized Home-Purchase Owner-Occupied Commercial-Bank-Issued 3.17 1.71 1.64 1.09 3.53 1.61 6.21 3.63 (0.86) (0.72) (0.48) (0.40) (0.66) (0.50) (1.79) (1.94) 4.59 2.62 1.90 1.63 4.39 2.17 9.12 6.35 (1.49) (1.27) (0.92) (0.70) (1.16) (0.84) (3.04) (3.23) 5.68 5.68 0.12 (HP Vol.) 2 0.12 % Wage log(population) % Population % Employment % Finance/RE Employment Share of Suprime, 2005 Share of Thrifts, 2005 Share of Refinancing, 2005 Share of Securitized, 2005 Share of Investment Homes, 2005 Share of Non-Single Family Homes, 2005 Constant 0.25 0.26 0.11 (0.09) 0.33 0.008 (0.006) (0.13) 0.23 0.09 0.38 2.13 (0.74) 1.02 1.55 (0.26) 0.78 (0.24) 0.35 (0.14) 0.52 (0.08) 0.21 0.21 0.38 0.015 (0.004) 0.12 (0.08) 0.17 (0.05) 0.01 0.16 0.51 1.63 (0.72) 0.19 (0.09) 0.63 0.44 (0.17) 0.16 0.38 (0.08) (0.05) 0.21 0.54 0.009 (0.005) 0.13 0.19 0.00 0.61 (0.14) 1.77 (0.77) 0.35 0.98 (0.19) 1.00 (0.22) 0.16 N 789 789 789 789 789 789 789 1578 1578 R 2 0.21 0.22 0.47 0.24 0.58 0.39 0.64 0.21 0.34 ***, **, *, + denote statistical significance at the 1%, 5%, 10% and 15% levels. (3.38) 0.48 (0.20) 2.70 (1.93) 0.07 0.10 (3.40) 0.44 (0.19) 2.70 (1.94) 0.07 0.42 (0.22) 0.002 (0.009) 0.01 (0.21) 0.12 0.01 (0.03) 0.06 0.73 (0.28) 4.16 (1.38) 0.86 (0.21) 1.05 (0.33) 1.19 (0.30) 0.67